I. Introduction

States are suffering from their worst budget problems since
the Great Depression. Thirty-one states accumulated a $31 billion deficit in
1991 alone. This follows on the heels of several years of budget distress in
state capitals across the country. In 1990, spending exceeded revenues in
two-thirds of the states while, in the Northeast, the first signs of fiscal
trouble appeared back in 1988.

According to a number of state budget analysts, states will
have to grapple with structural budget deficits throughout the 1990s. For
instance, Steven Gold, director of the Center for the Study of the States,
forecasts that in the 1990s, "It's virtually inevitable... The states will face
continuing fiscal stress."[2]

Analysts cite several causes for the states' fiscal
problems. These include:

The recent recession;

Skyrocketing costs in federally mandated programs such
as Medicaid and welfare;

Court-imposed spending requirements for areas such as
education and corrections.

The most important impetus for the budget problems of the
1990s, however, is that states can no longer afford to fund the rapid growth of
state spending that occurred in the 1980s. Between 1980 and 1989, state
spending grew by 104 percent. In most of the states now facing the worst budget
problems, spending grew even faster: by 119 percent in California; 174 percent
in Connecticut; 169 percent in Florida; and 134 percent in Massachusetts.[3]
Numerous programs were created during the state spending increases of the
1980s. These programs, in turn, have generated strong constituencies that now
resist attempts to terminate, cut, or slow the growth of these programs.

The main reason for the large growth in state government
was that tax receipts were growing very rapidly in the 1980s, so there were few
fiscal or political considerations restraining spending.[4] As demonstrated by Table 1, per capita tax receipts increased from $658 to $1,147 between 1980 and
1988. Describing the Northeast's fiscal problems in 1989, Steve Moore of the
Washington, D.C. based Cato Institute wrote, "The plight of the Northeast is a
classic case of the ratcheting effect of government. Higher revenues trigger
new spending, which quickly becomes a politically indispensable fixture of the
government.[5]

States are now finding it increasingly difficult, if not
impossible, to pay for the growth of state government that occurred in the
1980s. Reason: slow personal income growth and sluggish personal consumption
caused by the recession has resulted in diminishing tax revenues.

Many states have chosen to solve this budget problem by
increasing taxes, rather than by reducing spending. In fact, states have
enacted record tax increases in the last three years: $17 billion in fiscal year
1992; $10.3 billion in fiscal year 1991; and $5.5 billion for fiscal year 1993.
These tax increases are cumulatively larger than the total state tax increases
in the entire decade of the 1980s.[6]

STATE TAX INCREASES SLOW ECONOMIC GROWTH

A number of factors, however, are now working to slow the cycle of ever-increasing state spending and taxes. For one thing, turning to
higher taxes to solve budget shortfalls can have adverse economic effects.
Numerous studies in the 1980s indicated that high taxes reduced state growth
rates.[7] Among other findings, the studies revealed that tax increases can
have devastating impacts on a state's economy by:

slowing long-term growth and employment;

causing businesses to relocate to lower-tax states;

deterring businesses from moving into a state;

deterring the growth in the stock of capital;

reducing small business starts; and

inducing consumers to cross state borders to purchase goods.

During the 1980s, states with fast-rising taxes experienced
slower economic growth than states that kept taxes down. A 1981 study by the
Joint Economic Committee (JEC), for example, found income growth in states to be
inversely related to the level of state and local tax burdens and to the amount
and progressivity of income taxes in the state.[8] The inverse relationship
between states' relative tax burdens and economic growth rates was confirmed in
a 1988 study by A.B. Laffer Associates that examined the 1980-1986 period, and
by a 1991 study by University of Dallas economist Gerald Skully.[9]

Some proponents of tax increases acknowledge the adverse
economic effects of income and business tax increases, but contend that excise
tax increases, on the other hand, do not damage a state's economy. Recent
evidence, however, contradicts this notion. Increases in taxes on goods such as
gasoline, alcoholic beverages, or cigarettes, may cause residents to cross the
border into lower-tax states to buy certain goods, according to a 1992 Price
Waterhouse study done for the American Legislative Exchange Council (ALEC).[10]
As a result, these higher-tax states experience reductions in potential tax
revenue and business growth, while lower-tax states experience increases in
both.

State legislators and governors often contend that the tax
increases are necessary to eliminate government red ink. The evidence, however,
suggests that rather than solving long-term fiscal problems, these tax increases
typically lead to increases in government spending. In a study of state budget
data between 1952 and 1982, former U.S. Treasury Department economist Michael L.
Marlow and Neela Manage found that "tax receipts cause expenditures at the state
level of government."[11] In other words, revenue increases lead to spending
increases, rather than smaller deficits

TAXPAYER REBELLION

Citizen disillusionment with government and grassroots
resistance to higher taxes is growing. In Connecticut, Governor Lowell Weicker
had to escape via a tunnel when confronted with 65,000 angry voters who stormed
the state capitol in 1991 protesting a new 4.5 percent income tax.[12] A
grassroots revolt against tax increases in New Jersey led to a Republican
takeover of the state Senate and House in 1991. Taxpayers also turned nine
tax-raising governors out of office in 1988 and 1990.[13]

In addition, through taxpayer-sponsored state initiatives and referenda, citizens are making it increasingly difficult for politicians to
continue the record level of state tax increases. In Oklahoma, voters approved
in 1992 a ballot initiative requiring a three-fourths vote of the legislature to
enact any future tax increase. A similar measure, this requiring a two-thirds
vote, was passed overwhelmingly in Arizona in the November 1992 general
election. In Colorado, the general election voters approved by 54 percent to 46
percent a citizen initiative requiring voter approval of all state and local tax
increases as well as spending increases above inflation.

Also in the 1992 general election, measures calling for tax
increases were defeated in Missouri, North Dakota, Oregon, Oklahoma, and
California.[14] Spending-control proposals were approved in Connecticut and
Rhode Island, while large public-works bond issues were defeated in California
and New York.

Increasing citizen resistance to new and higher taxes, together with the documented negative economic consequences of state tax increases, is compelling politicians of both parties to seek alternatives to
business-as-usual. Thus privatization, a proven alternative to higher taxes
and/or deep cuts to essential services, is gaining attention as one of the most
promising approaches for addressing state and local fiscal pressures.

PRIVATIZATION TRENDS

A 1992 survey of state agencies conducted by Apogee Research and sponsored by the National Association of Comptrollers revealed that
interest in privatization is gaining rapidly in the states.[15] Fully 85 percent of the 158 state agencies that responded to the survey said that they
believed privatization will be a major tool to provide state services and
facilities in the next decade.[16] This represents an increase of 35 percentage
points in just three years.

Over 90 percent of survey respondents employ privatization
techniques. All of these contract out services; 30 percent have or plan to
privatize facilities; and over 15 percent have or plan to sell assets.

With regard to specific service areas, over 70 percent of
states responding now contract out services in corrections, health, higher
education and mental health.

Over 20 percent of states responding have, or will be,
preparing statewide or agency-wide privatization strategies. Three years
earlier, no state reported working on such a strategy.